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Law and Economics


The Sale of Treasury Stocks and Protection of Management Rights

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  • Author CHO. Sung Ick
  • Date 2017/05/01
  • Series No. KDI FOCUS No. 82, eng.
  • Language English
SUMMARY □ Treasury stocks play a vital role in retaining, protecting and transferring management rights in large enterprises. However, the sale of treasury stocks is essentially identical to the issuance of new shares in economic nature. Therefore, using treasury stocks to protect management rights could obscure the equal treatment of shareholders. Even if such practices are permitted for policy purposes, the government needs to put other measures into place to protect general and minority shareholders from the damages that may arise.

- The sale of treasury stocks and the issuance of new shares are the same in economic nature since both increase stock trade volume and seek outside funding.

- Within the legal system, the difference between the sale of treasury stocks and issuance of new shares seems to have been created intentionally during the legislative process. As a result, controlling shareholders are able to use treasury stocks to defend their management rights.

- Although identical economic natures do not necessitate identical regulations, policy considerations can be rationalized if the positive economic impact from the protection of management rights, through the sale of treasury stocks, is significant.

- It is often the case that having a single managing executive to control two companies is more economically efficient, in terms of business synergy and reduced transaction costs.

- Affiliated companies that are mobilized to help the controlling shareholder protect his/her management rights could suffer from a loss in efficiency, for instance lost opportunities for better investments.

- Unlike general and minority shareholders, because controlling shareholders take into account the control premium when deciding on the sale of treasury stocks, the gains are highly likely to be focused on them, creating losses for the others.

- The controlling shareholders’ decision to sell treasury shares to white knights could generate losses for general and minority shareholders since it is a ‘rushed sale,’ while the controlling shareholders reap the benefits of maintaining the control premium.

- Selling treasury shares to affiliated companies is mostly aimed at strengthening management control by increasing the holding stake and restructuring the entire group.

- If it is difficult to expect certain business synergies, the sale will not be welcomed by the purchasing company’s general and minority shareholders.

- In the mid- to long-run, the current laws and systems need to be revised so that the transaction of treasury stocks fits the economic nature.

- Even if the current laws and systems are maintained, regulations that could generate losses for general and minority shareholders need to be overhauled as soon as possible.
KDI VOD Report
When the US hedge fund management firm, Elliott Management,
opposed its takeover of Cheil Industries in 2015,
Samsung C&T proceeded to sell its entire treasury holdings to KCC Corporation.
Thereafter, using its newly acquired voting rights, KCC Corporation approved the merger.

The fact that such a transaction was possible is owed to Korea’s current laws,
permitting the sale of treasury stocks with only a board resolution.

the sale of treasury stocks and issuance of new shares are one in the same.
as both increase stock trade volume and secure outside funding.
a discrepancy exists between the two according to contemporary law,
and this, in turn, creates a loophole that can be made by companies
to protect their management rights.

Still, not all identical economic natures require identical legal regulations.

if the positive economic impact generated
from the sale of treasury stocks is significant enough,
considerations can be made within the legal system.

this study examines the economic impact of the protection of management rights
through the sale of treasury stock.

Take for example, a controlling shareholder who is managing
two different companies in two different sectors; companies A and B.
Then, an outside managing executive appears with the intent to obtain
the management rights of company B.

In response, in order to protect his or her managing rights,
the controlling shareholder mobilizes company A’s funds
to purchase company B’s treasury stocks.

If the increased efficiency and reduced transaction costs gained
through the integrated management of these two companies,
outweigh the damages caused by the sale of the treasury stocks,
i.e. the losses incurred from the rushed sale of shares and lost investment opportunities,
then the general and minority shareholders will still benefit,
even if the controlling shareholder uses treasury shares to protect
his or her management rights.

if the gains plus that from the control premium are larger than the loss,
the control shareholder will again use treasury stocks
to protect his or her management rights, despite the fact the gains
that can be obtained from integrated management are insufficient.

In this case, only the controlling shareholder will benefit
while the general and minority shareholders suffer from damages.

Then, how will the sale of treasury stocks affect general and minority shareholders?

Let‘s examine some real cases.

In 2003, as foreign investors began to aggressively purchase its shares,
Hyundai Elevator sold its treasury holdings to six white knights including KCC Corporation.

considering that the sale was rushed, it is highly likely
that the general and minority shareholders sustained damages,
while the controlling shareholders reaped the benefits
from maintaining their control premium.

Meanwhile, in 2008,
Hyundai Motor Company acquired Shinheung Securities
to launch HMC Investment Securities.
And upon its launch, HMC Investment Securities sold its treasury stocks
to Hyundai, Kia Motors, Hyundai Mobis, Hyundai Steel and Hyundai AMCO
to increase its holding stake.

given that little synergy was expected between the affiliated companies,
the transaction would have been unwelcomed by the general and minority shareholders
while it served as a prosperous opportunity for the controling shareholders
who were able to gain the management rights
by rallying the funds of affiliated companies.

As such,
in cases where the sale of treasury stocks is used
as a means to protect management rights,
the policy considerations must be rational
to ensure that management efficiency is enhanced.

And, restrictions must be enforced in cases of overprotection,
which have unfavorable consequences for the general and minority shareholders.

In the long-term, laws and systems should be reformed
so that the sale of treasury stocks reflects the economic nature.
Also, before implementing large-scale reforms on the current laws and systems
for treasury stock sales, regulations on selling practices that generate damages
for general and minority shareholders are urgently needed.
For example, the supervisory authority could enforce a screening process
for the sale of treasury stocks.
But, because voluntary regulation via the markets is more imperative
than governmental supervision, an overall systematic revision should be conducted
for the independent role of the board of directors
and general and minority shareholders’ damage claims, among others.
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